Question

Down Under Boomerang, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $2.37 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which it will be worthless. The project is estimated to generate $1,780,000 in annual sales, with costs of $690,000. The tax rate is 24 percent and the required return is 11 percent. What is the project’s NPV? 

Answer 1

Using the tax shield approach to calculating OCF (Remember the approach is irrelevant; the final answer will be the same no matter which of the four methods you use.), we get:

 

OCF = (Sales − Costs)(1 − TC) + TC(Depreciation)

OCF = ($1,780,000 − 690,000)(1 − .24) + .24($2,370,000/3)

OCF = $1,018,000

 

Since we have the OCF, we can find the NPV as the initial cash outlay plus the PV of the OCFs, which are an annuity, so the NPV is:

 

NPV = −$2,370,000 + $1,018,000(PVIFA11%,3)

NPV = $117,701.58